Do we have a debt bubble?
Bubble might be a tad emotive but suffice to say we are borrowed to the gills. Household debt has been steadily rising in Australia for the past 30 years, even after the GFC, which saw debt fall in other developed economies.
Australian households now hold debt on average of around 190% of household income – one of the highest levels in the developed world.
By comparison, Morgan Stanley recently put US household debt at 101% of income, the UK at 125% and the euro area at 95%. Of the countries surveyed, only Switzerland (195%) and Norway (224%) had higher debt ratios.
Our debt-servicing ratio was the highest of the countries listed, at 16% of income.
Morgan Stanley found Australia had the highest risk of a fallout from a reduction in borrowings if lenders cut the amounts they are prepared to lend in reaction to falling asset values and pressure from regulators to further tighten lending standards.
With debt levels so high and savings comparatively low, it estimated we could be hit by a $700 billion cut in wealth if falling house prices led to wider deleveraging. Institutions such as the International Monetary Fund have warned about household debt in Australia.
It said household leverage was an area of concern globally but particularly in Australia where house prices had increased. As a share of the local economy, it pointed out, household debt in Australia is at a record 122%, well above comparable countries.
How risky is it?
As usual, it comes back to the housing market.
According to Finder.com, owner-occupied mortgages make up around 56% of personal debt with investor debt (much of it in housing) making up another 36%. It says the average household owes around $250,000, though there are obviously big variations on either side of that.
Obviously the more debt you hold, the more vulnerable you are to falling prices.
Digital Finance Analytics estimates more than 1 million households (or around 30% of households with owner-occupier home loans) are now experiencing mortgage stress, which occurs when their cash flow does not cover ongoing costs.
It says more than 40% of households trying to refinance are having difficulty as lending standards tighten and they are urgently trying to reduce their spending.
Some households have more flexibility than others.
Around two-thirds of household debt is held by higher income households and lender ING recently found 82% of households pay more than the minimum on their home loan most years, though other estimates put the proportion of home loan borrowers ahead on their repayments at around 70%. Others are dipping into their savings to meet the gap.
The big picture
With wages growth low, households have been dipping into their savings to boost spending.
That is unsustainable over the longer term and a drop in consumer spending would have a broader effect on the economy. If debt deleveraging were also to occur, that could turn into an economic slowdown.
The broader implications of debt deleveraging would hit households with heavy borrowings first as they are the ones that might struggle to refinance or to meet their repayments. But falling house prices and any drop in consumer confidence and spending would have broader effects on the economy.
In September, Michele Bullock, the Reserve Bank’s assistant governor, said any difficulties in the residential mortgage market could translate into credit quality problems for the banks, with mortgages being such a large part of bank lending.
While our banks are well capitalised and have already tightened their lending standards, further tightening is not off the cards.
Did you know?
US households far outstrip us in terms of “bad debt” or debt used to fund lifestyle such as cars and credit cards. Finder.com says non-housing debt makes up more than 23 per cent of US personal debt compared to around 8 per cent here.
Best case scenario
Australia’s economy needs to keep growing to cushion the impact of falling house prices and tighter borrowing. There are positive signs for the economy in the non-consumer sectors that could help to offset any fall in consumer spending as debt is wound back.
Worst case scenario
The Morgan Stanley scenario assumes a 10-15 per cent fall in real house prices combined with a 20 per cent reduction in debt levels. That is in line with many other forecasts but there is obviously a risk of bigger falls.
The wild card
Australia remains vulnerable to what happens in the global economy and financial markets. Global debt has also been rising so any shock to the global economy could trigger wider problems for borrowers.